Reforms to change PNG capital market structure

Although small by international standards, Papua New Guinea’s capital markets have performed well in recent years, despite facing notable macroeconomic challenges. Key indices on the Port Moresby Stock Exchange (POMSoX) expanded steadily in 2017, supported by robust growth of two of its largest listed companies, Bank South Pacific (BSP) and Oil Search, and an increase in domestic turnover.

A series of regulatory reforms launched in 2015 – including the Capital Markets Act (CMA), Securities Commission Act (SCA) and Central Depositories Act (CDA) – have started to come into force, laying the foundation for stable growth and market modernisation. Efforts to upgrade the stock exchange were also supported by the launch of a new Nasdaq trading platform in late 2017, and the Bank of PNG (BPNG), the central bank, is considering the adoption of an electronic bond auction system.

Excess local currency liquidity is a major challenge, with capital markets investment and expansion limited by an ongoing foreign exchange (forex) shortage. However, capital markets are expected to maintain steady growth into 2019, supported by a planned eurobond issuance in late 2018 and the country’s gradual macroeconomic recovery, which should see sustained profitability and attractive shareholder dividends at major listed companies.

Through the Years

PNG’s capital markets date back to 1994, when the Stock Exchange Steering Committee – comprising representatives from the BPNG, the Department of Finance, the Registrar of Companies and McIntosh Securities – began developing a stock market framework. The framework was established in 1997, accompanied by the promulgation of the Companies Act and Securities Act. In 1998 POMSoX was incorporated as a private company, and the Takeovers Code was introduced. The PNG exchange was modelled closely on the Australian Stock Exchange (ASX), and in June 1999 trading began. POMSoX is regulated by the Securities Commission of PNG (SCPNG). The Takeovers Code was amended in 2013 to enable the SCPNG to block any acquisition that is in conflict with national interest.

Early initial public offerings (IPOs) on POMSoX included those from Oil Search and Steamships Trading. Both companies were already listed on the ASX before joining the POMSoX in 1999. New Britain Palm Oil listed in 2001, while Credit Corporation and City Pharmacy both listed in 2002, with BSP following shortly after in August 2003.

All of New Britain Palm Oil’s shares were acquired by Sime Darby Plantation in 2015, and it was delisted from POMSoX in April that year. As of August 2018 there were 14 companies listed on POMSoX, with the exchange reporting total market capitalisation of PGK54.4bn ($17bn) at the end of 2017.

System Upgrade & Foreign Investment

In November 2017 Nasdaq and POMSoX announced the exchange had officially launched its new Nasdaq Matching Engine, which operates on the Nasdaq Financial Framework platform. The new engine is an upgrade of POMSoX’s previous Nasdaq trading technology, first deployed in 1999, and it will handle all equities trading in the country and make it easier for foreign investors to enter the PNG market. In a November 2017 press release issued by Nasdaq, Johnson Kalo, board member of POMSoX, said the Nasdaq Matching Engine is expected to foster innovation in market design and offerings, support future growth, provide new opportunities in market data collection and distribution, and attract new investors.

Foreigners are permitted to trade on POMSoX, although foreign shareholding remains limited by an ongoing forex shortage, leading to rising concerns over excess liquidity in both the capital markets and banking sectors. “Presently, it is difficult to buy forex, so what we are seeing is domestic liquidity build up in the financial system,” Deepak Gupta, executive general manager wealth at Kina Bank, told OBG. “This is a concern because some corporate entities are beginning to invest outside of their key competencies – for example, in real estate – and excess liquidity can lead to poor capital allocation and eventually to potential economic dislocation.”

The government has nonetheless signalled its intention to attract new investment to the exchange. In April 2018 Wera Mori, the minister of commerce and industry, announced that the government was planning to draft new laws that would open the bourse to further foreign investment. Reforms could include expanding POMSoX’s regulatory framework to allow for listings of special investment trusts, such as special-purpose entities, which could be used for large infrastructure and development projects.

Stockbrokers

There are two brokers licensed to trade on the bourse: BSP Capital (BCAP) and Kina Securities. BCAP was established when BSP, PNG’s largest commercial lender, acquired Capital Stockbrokers in 2005. Since then, the company has grown to become PNG’s leading stockbroker, accounting for an estimated 80% of daily POMSoX trades as of mid-2018. A founding member of the stock exchange, BCAP holds a 62.5% stake in POMSoX. In addition to assisting its parent company with capital-raising activities in Fiji and PNG, BCAP also acts as a licensed investment manager for large government-mandated clients, including superannuation funds, savings and loan societies, and landowner groups.

Kina Securities, the holding company for Kina Bank, listed on the ASX in 2015 with an IPO valued at $97m, and used the proceeds for its Maybank acquisition. Kina Bank Wealth Management (KBWM) oversees Kina Funds Management (KFM), PNG’s largest licensed investment manager and the KBWM sharebroking division. Between 2015 and mid-2018, KFM funds under management rose from PGK5.2bn ($1.6bn) to PGK6.5bn ($2bn). According to KBWM, it accounted for 62% of trades on POMSoX in 2014; however, according to recent figures from BCAP, KBWM no longer accounts for the majority of trades.

Macro Slowdown

POMSoX has felt the effects of a macroeconomic slowdown that began in 2014, when a long boom period driven by construction of the ExxonMobil-led PNG LNG project came to a close, which was roughly around the time global oil and commodity prices began to plummet. Brent crude prices dropped from a high of $115 per barrel in June 2014 to less than $50 per barrel in the opening months of 2016, exacerbating a commodity down cycle that started in 2012, affecting copper, gold and palm oil prices. PNG’s GDP growth decelerated significantly from 12.5% in 2014 to 2.5% in 2017, according to data from the IMF.

POMSoX is measured on two indices: the Kina Securities Index (KSI), which measures PNG-related shares including dual listings, and the Kina Securities Home Index (KSHI), which only measures shares traded domestically. Given that the first measurement is dependent on the performances of foreign companies with a share in PNG’s market, it can explain for the stark discrepancy in recent market results. Kina Group reported that the KSI contracted by 2.3% in 2015, while the KSHI rose by a marginal 0.5%. In June 2016 Vincent Ivosa, acting general manager of POMSoX, told local media that trading on the exchange had dropped by 43% year-on-year (y-o-y) in the first half of 2016, while the KSI rose by 36.9%.

However, KBWM reported robust growth in 2016 and 2017, with the KSI rising by 40.8% and 13.6%, respectively, and the KSHI expanding by 10.7% and 2.5%. The group noted that this trend also applied to Australian securities, which contracted by 0.8% in 2015, before rising by 7% in 2016 and 7.8% in 2017.

While challenging business conditions continued into 2017, BSP reported that total market turnover on POMSoX more than doubled that year, reaching PGK74m ($23.1m) against PGK31m ($9.7m) in 2016. According to the bank, the growth was supported by increased share trading of BSP and Oil Search.

Top Performers

Newcrest Mining shares were the top performers in 2017, with share price increasing by 23.9%, followed by BSP shares, up 5.6%, and Oil Search with 3% growth. Between January and June 2018 mining firm Highlands Pacific saw the biggest gains, with shares rising by 25% y-o-y, followed by Oil Search with 6.3% and BSP with 5.3%.

After registering record production for the fourth year in a row (see Energy chapter), and benefitting from a gradual recovery in oil and gas prices, Oil Search’s net profits increased by 236% from $106.7m in 2016 to $302.1m in 2017. Investors benefitted from the recovery, as dividends paid per share nearly tripled from $0.035 to $0.095.

BSP also ended 2017 on a positive note, with the bank reporting that net profits after tax increased by 17.6% to PGK757m ($236.3m), while operating profits grew by 15.6% to PGK1.07bn ($334m). The institution has also distributed earnings to its shareholders, with dividends paid per share more than doubling since 2012, rising from PGK0.55 ($0.17) to a six-year high of PGK1.11 ($0.35) in 2017. Meanwhile, return on equity increased from 29% in 2012 to another six-year high of 30.6% in 2017.

Bond Market

Although development has been limited, PNG’s bond market holds considerable potential for future growth. In its December 2017 economic update for PNG, the World Bank reported that low take-up of Treasury bills and bonds by commercial banks in PNG had pushed the BPNG to purchase the excess. BPNG’s net holdings of government debt have increased sharply since 2016, with held government debt outbalancing the amount of central bank bills issued. This is attributable to a sharp increase in the government’s debt interest costs, which the World Bank estimated at 2.2% of GDP, which is more than the education budget. BPNG is therefore striving to avoid interest rate increases on government debt.

BPNG has begun to on-sell some of its government paper holdings to the public, offering a crucial channel to address rising levels of public debt. According to the World Bank, public debt rose to 35.4% of GDP at the end of 2017, exceeding the upper limit of 30% set in the Fiscal Responsibility Act, and putting the country at risk of debt distress. This is problematic given the “increasingly short-term profile of government debt, with Treasury bills becoming ever more prevalent, which in turn increases rollover risks”, according to a December report by the World Bank.

Bond Issuance & Securities Reform

Although investment remains constrained by the forex shortfall and lack of a global custodian, the public debt market continues to offer considerable opportunities to potential investors. Bond market development will be supported by a planned issuance of the country’s first-ever eurobond. The government announced in May 2018 that a $500m, 10-year bond will be launched later in the year (see Economy chapter).

Near-term capital markets growth will also be bolstered by a string of ongoing reforms aimed at improving stability and transparency, as well as modernising existing trading and depository systems. The central bank has formulated a pair of financial services reform strategies called the Vision and Strategy for future PNG National Payments System (NPS), with the latest iteration running from 2015 to 2018. Launched in November 2015, the second NPS strategy includes several imperatives for securities market reforms, including the development of an electronic central depository system.

In June 2015 Prime Minister Peter O’Neill unveiled a series of planned legal reforms for PNG’s capital markets, which comprises the SCA, the CMA and the CDA. Proposed changes include transforming the SCPNG from a division of the Investment Promotion Authority (IPA) into an independent government agency, enabling it to improve its own regulatory enforcement and compliance. The new regulations also stipulate that SCPNG approval will be required for any corporate or unit trust listing or quotation of securities, acquisition or disposal of any asset involving a significant policy amendment in the business direction of a listed entity, amalgamation involving a listed corporation and offer of unlisted securities, such as foreign securities.

Existing requirements for prospectus issuance in the event of an IPO would also be replaced with a broader obligation applying to all general issuances except for wholesale offers and secondary trading, while offers of interest in collective investment schemes, such as unit trusts, would be regulated separately for the first time.

Meanwhile, reforms to POMSoX target improving competition and transparency by altering its ownership structure and board composition. The authority has also been working to upgrade the exchange, as well as engaging a consultant to assist in the restructuring of the SCPNG. Opening up the POMSoX is expected to enable more small and medium-sized enterprises to participate in the market.

Capital Markets Act

Implementation of the interrelated CMA, SCA and CDA of 2015 was delayed for several years, but the first of the three legislative packages officially came into effect on December 15, 2017, marking the beginning of a period of sweeping reforms to modernise and mature PNG’s capital markets. The CMA replaced the Securities Act 1997 and its associated regulations, and also transitioned the SCPNG from being a division of the IPA to an independent, autonomous entity.

The SCPNG is seeking to avoid piecemeal, reactionary reforms with the launch of a Capital Markets Development Strategic Master Plan 2018-30, which will holistically review the current business processes and regulations. This could see new amendments being made to the Takeovers Code, the Corporate Governance Code, and licensing processes for trustees and fund managers. The SCPNG is also set to examine reforms to POMSoX, as well as the development of the bond and derivatives market.

Under the new capital markets legislation, any individual who is involved in the business of securities dealing, derivatives trading, funds management, corporate finance, investment advisory services or financial planning in the country must now hold a capital market licence.

Limited exceptions apply to entities already established under the Banks and Financial Institutions Act 2000, as well as those engaged in activities that are incidental to the capital markets sector, such as accountants, valuers and receivers. Anyone representing a capital market licence holder is subject to separate licensing requirements.

The act also introduces stringent compliance obligations regarding the maintenance of registers of interest in securities, as well as client recommendations, client order prioritisation, holding client funds separate from other funds and annual audits. Under the CMA’s licensing system, minimum capital requirements for licence holders will be introduced, in addition to “fit and proper person” requirements for directors and executives.

However, Australian law firm Allens noted in February 2018 that stakeholders should not underestimate the lead time and work involved in obtaining a licence, pointing out that there are still gaps in the infrastructure needed to implement the act’s provisions.

CMA regulations were still being drafted as of July 2018. While the act is linked to the SCA and the CDA, with all three containing interdependent provisions, both the SCA and the CDA have yet to come into effect. There is also concern about new provisions stipulating that POMSoX shareholders cannot own any stake in the bourse, and that only corporates – not individuals – are allowed to become stockbrokers.

Central Depository

Updating the bourse through the adoption of digital technology remains a priority, and in its most recent NPS strategy, the BPNG reported that early securities-related NPS reforms focused on developing and implementing a central securities depository (CSD).

The CSD would provide an online centralised electronic registry for all of the government and central bank’s securities, which would meet the needs of stakeholders, including issuers, bidders, holders and managers, by providing records of all securities and their holders in book-entry form.

According to the central bank, a CSD system supports electronic securities clearing and transaction settlement, intraday liquidity management and BPNG monetary policy operations, in addition to facilitating electronic repurchase agreement processing. It can also calculate coupon, maturities, roll-over and tax payments; keep a consistent record of securities ownership; as well as support portfolio management and provide an online enquiry mechanism.

The CSD would also include an integrated primary market system to automate bidding processes for allocating and issuing government and BPNG securities, with auction results automatically updated at the same time the corresponding payments are made.

The CSD was intended to replace POMSoX’s simple Registry and Money Market System (RMS), offering the opportunity to introduce an electronic secondary market trading system for government and central bank securities in the future, to be carried out in consultation with SCPNG and POMSoX officials.

Limited Progress

The BPNG planned to issue a single request for a new automated transfer system and the CSD, with both systems closely linked, although it ended up commissioning a major extension to its registry and money market system functionality from its existing software supplier. The plan to procure a new CSD was shelved after the BPNG implemented its kina automatic transfer system (KATS) in 2013; however, the central bank reported in late 2015 that the new interface does not support automated collateralisation of intraday liquidity.

Furthermore, the World Bank’s 2015 review of the system identified shortcomings in the interface between KATS and RMS. It drafted several recommendations, including calling for “automated clearing and settlement and a CSD as key infrastructure developments for the interbank, government securities and central bank bills markets”.

In its NPS strategy, the BPNG reported that it had been evaluating a Bloomberg bond auction system for automating the present manual auction process used for government and central bank securities. The automatic auction system could also be adopted for all future Treasury and central bank bills, and government inscribed stock.

However, some stakeholders have argued that finding a qualified global custodian remains a more important priority for POMSoX authorities. PNG’s exchange is not currently served by a global custodian, which poses a significant challenge to the development of its bond market, as many institutional investors are unable to buy into markets without using a global custodian as an intermediary.

Outlook

Although it maintained steady expansion in 2017, POMSoX growth has moderated more recently, with the KSI contracting by 4.5%, while the KHSI expanded by 3.2% between January 1, 2018 and June 8, 2018. However, this is – once again – in line with Australian market trends, with the KBWM reporting that the All Ordinaries Index in Australia recorded 0% growth over the same period.

Outdated infrastructure, an ongoing forex shortfall and delayed reforms will continue to challenge capital markets stakeholders in 2018; however, the sector retains significant investment and growth potential. Major listed companies remain healthy and profitable, and the country’s ongoing macroeconomic recovery should keep the sector on an upwards trajectory in 2018. Nevertheless, addressing infrastructure and regulatory gaps remains a critical priority for investors and government authorities.